With oil at $130/barrel and gold at $850/ounce, commodities have gone mainstream.

Commodity-producing companies like Exxon and BHP Billiton play an increasingly important role in the global economy, and commodities - in various guises - play an increasingly important role in investors' portfolios.

Index providers and exchange-traded fund developers have jumped on the trend. Thanks to the ETF revolution, you can now choose from eight flavors of broad, index-based commodities futures ETFs, linked to indexes like the S&P GSCI, DJ-AIG and UBS CMCI. That's on top of any number of ETFs covering microcosms of the commodities world - water, solar energy, traditional energy, agriculture, gold, etc.

Against this backdrop, Jim Rogers and  S-Network indexes have launched a new commodities index this week: the Rogers Van Eck Hard Asset Producers Liquid Index (RVE for short.)

Why does the world need yet another index? We asked Jan Van Eck, executive vice president of Van Eck Global. "There's been a lack of a good benchmark for commodity equities," he claims.

And come to think of it, he's right. So much of the excitement in the commodities space has focused on commodity futures; that's been the site of basically all the innovation in the index field. In fact, the whole exchange-traded note diversion seems to have been created almost out of whole cloth to deal with the challenges of nonequity indexes. Commodities have taken center stage in the global economy, but there's been no effort to develop good, investible equity indexes to capture this increasingly important part of the global economy.

The closest thing we had until now was the S&P North American Natural Resources Sector Index, otherwise known as the GSSI. It forms the basis for an iShares ETF with the same name, which is traded under the ticker symbol IGE.

But the shortcomings of the GSSI are obvious. First, it's a U.S. index, when many of the largest commodity-producing companies are located overseas. Second, like so many attempts to capture the commodity economy, it's essentially an energy index, with an 85% allocation to the energy space. The long-term performance gap between the GSSI and the U.S. Energy Sector is negligible - the two returned within 1% of one another in 2007.

This new index - the RVE - tries to do a better job of capturing the global commodities sector.

The Universe: Finding The Cows

So how does it work? The RVE is derived from the full universe of global commodity-producing companies - some 900-plus firms. The index starts by sticking these companies into one of six sectors:

• Energy
• Agriculture
• Base/Industrial Metals
• Precious Metals
• Alternatives (including Water)
• Paper & Forest Products

Not every company in the index produces a commodity itself (despite the index's name) but instead can provide goods or services to others to produce commodities. For example, Monsanto, which holds the top spot in the index with a weighting of 4.58%, doesn't actually grow corn or cotton. But if you want to grow corn or cotton (or practically anything else that creeps out of the Midwestern soil), you're on credit with a Monsanto distributor for seed, fertilizer or some bizarre chemical guaranteed to kill something or other.

To be eligible for inclusion, firms must derive at least 50% of their revenues from commodity production or products and/or services that contribute to commodity production. The 50% screen is designed to ensure that the index focuses on pure-plays in the market.

The only exception to the 50% rule is in the water sector. Pure-plays in water are few and far between. For example, most companies that manufacture pumping or water distribution equipment sell to a variety of businesses, not just water companies. To include water in the index, companies that make 25% of their revenue from water are included in the sector.

Once this universe of 900-plus names is created, the index is screened for liquidity and investability, which narrows the investable index down to 310 names (many commodity-producing companies are located in markets that are off-limits to foreign investors, such as domestic Russia, Saudi Arabia, etc.).

These 310 names, drawn from 39 different countries, make up the RVE index.

Weights: Who's Buying The Milk?

With any index, especially a broad-based one, weighting is a critical factor. That's particularly true in the commodities market, where the distribution of market capitalization doesn't necessarily reflect the underlying importance of a sector. For instance, a market-cap approach will emphasize energy names, thanks to the huge global role of companies like Exxon-Mobil in the economy. By contrast, agriculture will be underemphasized, as a lot of food production is driven by private entities like family farms or Cargill.

In creating this index, Rogers and index-provider S-Network decided to look at the consumption side of the equation. "We analyzed global consumption, normalized it into U.S. dollars and then created the sector weightings," explains Joe LaCorte, managing member of S-Network, the company that is working with Jim Rogers to maintain RVE. "We rebalance back to those weights on a quarterly basis."

 Prev123Next